Income-driven repayment plans are designed to set monthly student loan payments at an affordable amount based on an individual’s income and family size. The payments are generally a percentage of an individual’s discretionary income – the amount of income left over after the necessities have been paid for. Monthly payments range from 10 – 20 percent of discretionary income, depending on the plan.
The Federal Student Aid program currently offers four income-driven repayment programs for student loans, each with distinct benefits. In this article, we’re exploring the advantages and disadvantages of income-driven repayment plans to discover whether they are a good option for healthcare professionals with significant student loan debt.
- Pay As You Earn (PAYE) Plan
The PAYE plan caps monthly payments at 10% of discretionary income and has a repayment term of 20 years. At the end of that period, any balance remaining will be forgiven. These terms are very similar to other income-driven repayment plans; however the PAYE plan has one more benefit that gives it an edge over most of the others. In addition to capping the monthly payment, this plan also caps the capitalized interest at 10% of your balance when you first enter the program.
When your monthly payment is too low to cover the interest accumulating on your loan, it’s called negative amortization. When this happens, the amount you owe is goes up even though you are making payments. In the case of student loans, negative amortization can occurr during periods of deferment or in you income-driven payment are very low. Most income-driven plans offer interest subsidies to borrowers have partial financial hardship, meaning their income-driven payment is lower than the amount they would pay under the standard repayment plan. But if their income rises to a point where they no longer meet that qualification, then they become ineligible for subsidies and unpaid interest is capitalized – or added to the total sum of your loan..
That may not sound so bad, but because the accumulated interest is often a fairly large sum of money – as much as $10,000 – $20,000 – it significantly increases the total amount that you owe when it is added. After that, interest is based on the new, larger loan debt, meaning you are paying interest on interest. This can lead to higher monthly payments.
Besides rising income, another way to incur interest capitalization under income-driven repayment plans is failure to properly report your earnings each year. If this happens, you are disqualifies from your plan, enrolled in the standard repayment plan, and your unpaid interest is capitalized. Often, it’s because they are kicked off their plan after failing to properly report changes in their income. In such a case, one small oversight can be very costly – unless you were on the PAYE plan.
Other income-driven repayment plans do not place a limit the capitalized interest. So, for example, if you owe $85,000 and $15,000 in interest as accrued overtime when you leave the PAY plan, only 10% of your original loan amount ($8,500) is added to your total. Other plans would capitalize the entire amount.
The primary disadvantage of the PAYE plan is its tighter requirement for eligibility. Not all federal student loans qualify for this program, and those who apply must have a partial financial hardship to qualify.
- Revised Pay As You Earn Repayment Plan (REPAYE Plan)
Like the PAYE plan, the REPAYE program sets monthly payments at ten percent of the borrower’s discretionary income. Repayment Periods are 20 – 25 years, at which point the remaining balance will be forgiven. Unlike the PAYE plan, most direct federal student loans qualify for REPAYE.
Another advantage of this plan is that it provides generous subsidies to cover interest. All income-driven repayment plans feature subsidies that pay toward interest on student loans for students with partial financial hardship. But of all the programs, the REPAYE Program provides the most generous subsidies, with 100 percent of interest covered for the first three years and 50 percent for the remainder of the repayment term. In addition, REPAYE also covers 50 percent of interest for unsubsidized loans (i.e., loans covering postgrad) for the full term of the loan. In contrast, the PAYE plan merely covers 100 percent of interest for the first three years for subsidized loans.
It’s important to not that if the borrower no longer has partial financial hardship, then they no longer qualify for these subsidies and the interest that has accrued is capitalized. Under the REPAYE plan the amount of interest accrued will be smaller, which may save you money in the long run. Whether REPAY’s subsidies are more more advantageous than the loan capitalization cap offered by the PAYE plan depends on your particular circumstances. The PAYE Plan’s capitalization cap is like insurance in case you decide to leave the plan, or if you get kicked off. The subsidies provided by the REPAYE plan are like a discount that keeps your interest from snowballing in the first place. We recommend discussing which option is right for you with your loan servicer.
Another potential advantage is there is no cap on your monthly payments. Under the PAYE program, your monthly payment is set at 10 percent of your discretionary income, unless that amount exceeds the what you would be paying under the standard repayment plan. If it does exceed that amount, then you are transferred to the standard plan where you will make fixed monthly payments based on your total student debs and the number of year you plan to pay it off. Under the REPAYE plan, you pay 10 percent of your discretionary income, no matte what that amounts to. Additionally, you can make extra payments to pay down your loan while still staying on the plan – something you cannot do under other IDR plans. If your income ever shrinks, you have the option of going back t paying 10 percent. For some, the lack of a cap on monthly payments may be considered a down side. After all, it means you may end up with higher monthly payments than other plans. For others, though, the flexibility that this plan provides is a plus. Ultimately, it depends on how steadily you expect your income to increase over time.
One disadvantage to the REPAYE plan is that monthly payments are based on household income. So, if you’re married, your spouse’s income will factor into the payment calculation. Under the PAYE plan, only you income is factored if you file separately from your spouse.
The REPAYE Program is available to all borrowers of federal direct loans, except parent PLUS borrowers.
- Income-Based Repayment Plan (BR Plan)
Figuring out monthly payments under the Income-Based Repayment plan can be a little confusing, but the plan provides financial benefits worth putting effort into finding out.
Income-based repayment plan sets monthly payments at 10% for individuals who took out direct federal loans after July 1, 2014, and 15% for individuals taking out loans after that date. The primary advantage of this program is that some borrowers who do not qualify for the REPAYE Program, such as Federal Family Education Loan (FFEL) borrowers, qualify for this program. Another advantage is that individuals who are married can exclude their spouse’s income if they file separately, which means monthly payments are based on your personal income rather than household income.
Like the PAYE plan, applicants must have a partial financial hardship to qualify.
- Income-Contingent Repayment Plan (ICR Plan)
The Income-Contingent Repayment Play is generally not the best option for borrowers of federal student loans. Monthly payments are capped at 20% of discretionary income, and the repayment period is 25 years, making it the most lengthy and expensive option for income-driven repayment. The one benefit of this program is that parent PLUS borrowers are eligible, making it pretty much the only option for those individuals.
To be more specific, parent PLUS borrowers do not technically do not qualify for ICR, however borrowers can consolidate their parent Plus loans into a Direct Consolidation loan and repay under the ICR plan. They cannot do this under any other IDR plan.
Are Income-Driven Repayment Programs Right for Healthcare Professionals?
For healthcare professionals, the advantage of these plans is they make it easier for individuals just starting their careers who earn a relatively small income to afford their monthly student loan payment payments. As your career progresses and your earnings grow, you pay more in order to avoid incurring too much interest. Any remaining balance on the loan at the end of the repayment period is forgiven, canceling out the additional interest incurred during the longer repayment periods associated with IDRs, which range from 10 – 25 years.
So far, it may sound like a great deal. However, there’s one big catch. The debt that is forgiven at the end of your repayment term is treated like taxable income, meaning that it may bump you into a new tax bracket and cost you a pretty penny in taxes that year.
At current interest rates, student loan debt from medical school can double after ten years. Currently, medical school graduates are walking away with an average of $200,000 in dept. Graduate-level nurses have as much as $54,000 in student loan debt. Across the board, healthcare professionals have more student loan debt than students graduating in other fields.
It is possible to make extra payments under income-driven plans in order to pay off your loans faster. However, if you own are large sum in student debts, you will need to manage your payment carefully in order to drive down the amount you will owe in taxes when your remaining balance is forgiven at the end of your repayment term. Simply making the minimum payment required could cost you.
To sum up the disadvantages of income-driven payment plans for medical school loans: the lengthy repayment periods mean a lot of interest is accrued. Also, another monthly payment to manage means your cash flow will be affected for a lengthy period of time. Finally, you may potentially take a hit on taxes at the end of your repayment period.
Moreover, if you leave the REPAYE, PAYE, or IDR plans, your interest is capitalized. For the PAYE plan, capitalization is limited to 10%, but for the other plans, it’s not. Leaving these plans is not always voluntary. For example, if you do not properly report your yearly income, you may be kicked off your plan, at which point your interest will be capitalized and you will end up paying a lot more in the long run.
Much like student Loan Forgiveness programs, the benefits of income-driven repayment plans really depend on your specific circumstances. If you aren’t able to afford monthly payments under the standard repayment plan, then an income-driven option may be right for you. But if you can, you may be better off sticking with the standard plan or one of the other options, such as the graduated repayment plan, and paying your loan off faster.
For individuals working in a wide variety of professions, income-driven repayment plans offer relief from burdensome student loan payments that prevent them from buying a home, starting a family, taking vacations, or even contributing to their retirement fund. However, because they tend to have higher earnings than most other job categories, many healthcare professionals may find their ability to pay their loans down fast restricted by these plans.
Another repayment option that makes more sense for healthcare professionals is a graduated repayment plan, which offers monthly payments that are low at the outset but which increase every two years. We will discuss the graduated repayment plan in more detail in a future article.
How Hippo Can Help
At Hippo Lending, we help a substantial number of healthcare professionals consolidate their debts into one monthly payment. Sometimes these debts include student loans. Each case is individual and consolidating your student loans may not make sense. However, other debts that you have accumulated alongside your student loans may be right for debt consolidation. At Hippo Lending, our member advisors work with you to tailor the best debt consolidation solution to your particular needs. Unlike repayment plans, which set a lower payment amount but drag out the payment period for great lengths of time, debt consolidation can lower your total loan payments by offering a competitive interest rate combined with a repayment period that takes your preferences into consideration. So, you have a choice between paying less now – which sometimes is the preferable option – or paying less overall – which also has its advantages.